I'm reviewing how we use our HSA and am struggling to understand the advice listed in the Wiki regarding when to pay out of pocket vs. HSA savings. In particular, these quotes...

"If you are not maxing out your retirement accounts, you should usually pay current expenses from the HSA. If you are in a 25% tax bracket and have $1,000 in medical bills, taking $1,000 from the HSA, and taking advantage of the fact that this wasn't an out-of-pocket expense so that you can invest an extra $1,000 in your Roth IRA or $1,333 in your 401(k), works to your benefit.

If you kept the $1,000 in the HSA and paid the expense out of pocket, you would have the right to withdraw $1,000 from the HSA later to cover the expense and spend $1,000 on anything later. But if you invested the $1,000 in a Roth IRA, you gained the right to spend not only that $1,000 on anything in retirement, but also the gains on that $1,000; if you invested $1,333 in a 401(k), that is just as good after adjusting for the 25% tax you will pay in retirement."

My wife and I max out our HSA, max out our Roths, but we have a long way to go to max out our 401k. I get that we want to maximize that space. Wiki states that as long there is tax advantaged space available, pay medical expenses from HSA and use the money you would have spent and invest. Here's where I get hung up...

If I spend $500 from the HSA and manage to put $500 into a Roth, have I really added anything to my tax advantaged space? I've netted out zero it seems so why couldn't I just spend out of pocket and leave the HSA funds alone? In our case, the only extra space we have available is our 401k, but of course that isn't as easy to contribute extra money to as a Roth. So that's another reason why I wonder if just spending out of pocket vs. HSA funds is Ok.

I've got about $500 in Dental/Vision expenses I know will occur in 2015, so I'm trying to decide if I should try to plan for them to spend expense wise vs. just paying out of HSA when it comes along.

Drew31 wrote:If I spend $500 from the HSA and manage to put $500 into a Roth, have I really added anything to my tax advantaged space? I've netted out zero it seems so why couldn't I just spend out of pocket and leave the HSA funds alone?

The idea here is that the $500 you put into your Roth will grow, and in retirement you will be able to withdraw the ($500 + growth).
Whereas if you pay $500 out of pocket and leave $500 in the HSA, you can only withdraw that $500. In other words, your expense right now is what it is, whether you withdraw that amount from the HSA tomorrow or 30 years from now, it will stay at $500 without any growth.

In our case, the only extra space we have available is our 401k, but of course that isn't as easy to contribute extra money to as a Roth. So that's another reason why I wonder if just spending out of pocket vs. HSA funds is Ok.

Yeah this is a bit tricky. Not sure what the correct approach is here.

d0gerz wrote:
Whereas if you pay $500 out of pocket and leave $500 in the HSA, you can only withdraw that $500. In other words, your expense right now is what it is, whether you withdraw that amount from the HSA tomorrow or 30 years from now, it will stay at $500 without any growth.

So I guess this is confuses me in that if you are invested in the HSA, the $500 will continue to grow as well. So in either case you'll have $500 growing, so it seems its just a matter of where you want that 500 growing. In our example, would I rather have the 500 growing tax free in a HSA or in a 401k where I'll eventually have taxes. (Understand the HSA is only tax free if used on medical expenses).

I'm really just trying to understand the reasoning behind that Wiki advice and this section you stated above has thrown me for a loop because I'm not getting it.

Sorry, I'm probably not doing a great job at explaining. Let me try one more time.

As you stated, the money in the HSA you can only withdraw tax-free if it's for a medical expense.
So say from now onward in your whole lifetime you only incur this one $500 expense next year.

If you pay from the HSA right now, and contribute an equivalent $500 to a Roth IRA, at retirement you can withdraw all of the $500 + earnings tax-free and use it for whatever you want.
If you pay out of pocket right now, and leave the $500 in the HSA, at any later point in time you will only be able to withdraw the $500 i.e. the original expense that you incurred. Sure there will be earnings on the $500 in the HSA as well, but you won't be able to access them tax-free, because you don't have any more medical expenses. So essentially what you're giving up is tax-free growth of earnings.

d0gerz wrote:Sorry, I'm probably not doing a great job at explaining. Let me try one more time.

As you stated, the money in the HSA you can only withdraw tax-free if it's for a medical expense.
So say from now onward in your whole lifetime you only incur this one $500 expense next year.

If you pay from the HSA right now, and contribute an equivalent $500 to a Roth IRA, at retirement you can withdraw all of the $500 + earnings tax-free and use it for whatever you want.
If you pay out of pocket right now, and leave the $500 in the HSA, at any later point in time you will only be able to withdraw the $500 i.e. the original expense that you incurred. Sure there will be earnings on the $500 in the HSA as well, but you won't be able to access them tax-free, because you don't have any more medical expenses. So essentially what you're giving up is tax-free growth of earnings.

Thanks for taking the time on this. I'm beginning to get what you're saying. I'm going to need to re-read this and the wiki a few more times to truly let it sink in, but I think the perspective you're framing it in helps.

Money going into the HSA and 401k is pretax. So if you earn $100k in a year and are in the 25% federal and 5% state tax bracket, it works like this:
Scenario 1: No money into HSA or 401k; $100k has 30% income taxes; net take home is $70k, no retirement savings
Scenario 2: $3300 into HSA + $7700 into 401k; you pay 30% tax on the remaining $90k; net take home is $63k, with $10k retirements savings = $73k

Now you have $500 in med expenses, so you can do two things:
Scenario 3: Same as #2, but with $500 in medical expenses, which you pay out of the $63k net take home, leaving you $62.5. If it is your only expense of the year, you still pay $27k tax, and still have $10k in retirement savings.
Scenario 4: Same as #2, but you are going to fund the $500 out of HSA and put $500 to the 401k. However, at 30% tax rate, putting the $500 into your 401k saves $150 in taxes. Now you have $2800 in HSA + $8200 into 401k, net take home of $62,650, with $10k in retirement savings.

Another way to look at it is to get the $500 cash to pay the medical bill outside the HSA, you need to earn $650. If you use HSA funds to pay the $500 medical bill, and send that $650 in earnings to your 401k, you have the same net take home, but you took $500 out of the HSA and put $650 into the 401k.

It seems the key to this is that if you're going to use HSA dollars to pay for expenses, you should be putting that amount into a tax advantaged account.

The example I keep thinking of is I incur let's say $100 of expenses in a month. I could either pay from HSA or cut back on some other expenses (let's say dining and entertainment for simplicity sake) to pay the expense. It seems there are 3 scenarios.

1. Pay expense from HSA. Do not contribute extra to 401k. Do not cut monthly expenses.

2. Pay expense out of pocket by cutting expenses. Do not withdraw from HSA. Do not contribute extra to 401k.

Money to HSA all subtracts from income on page 1 of 1040.
HSA investments grow tax free until withdrawn.
HSA withdrawals are always tax free as you may use collected medical receipts not used for tax deductions for many years past and present.

A plus to HSA compared to Roth for some situations is below: If your employer is contributing some money to HSA, it is free money. If you are contributing to HSA through payroll, you also will save on SS+Medicare taxes, if your income limit is less than or equal to the ss taxing limit.

I should clarify, I have no doubt regarding the benefits of maximizing HSA contributions. I max it out first before anything else. What I'm trying to make sure I understand (and maximize) is how I'm using those funds once they're in the HSA.

I'll be new to this HSA thing next year. I plan to pay medical expenses with it as we incur them. I would not want the hassle of keeping receipts for 20 years or whatever.

I did not even care if this was the "best" way, but I guess it is as we probably will not be maxing out retirement accounts or if we do it'll be just barely so. In any case, it seems to me to be the least annoying way to just use the thing for it's intended purpose.

I don't understand the examples that are like "pay expense from HSA, contribute that amount to 401k."

What? I understand the examples where you contribute the money to a Roth IRA, but I don't understand how paying medical expenses from your HSA has anything to do with contributing to a 401k afterwards.

JustinR wrote:I don't understand the examples that are like "pay expense from HSA, contribute that amount to 401k."

What? I understand the examples where you contribute the money to a Roth IRA, but I don't understand how paying medical expenses from your HSA has anything to do with contributing to a 401k afterwards.

It is about the total amount you have in tax advantaged accounts. It assumes you have the cash to pay the $500 medical expense from take home income. Should you do that or should you allow yourself to be reimbursed from the HSA for the $500 expense?

If you pay a $500 expense from the HSA, your HSA is down $500. Presumably you have hit your annual HSA max, so you cant top it up. So instead, you put that amount (or hopefully more) in your 401k. That way using $500 of the HSA did not decrease your total tax advantage account balance by $500.

If you pay the same $500 expense out of pocket, instead of from the HSA, it cost you $650 in earnings to get there, because you had to pay $150 taxes on the $650 to net $500.

If you are maxing your HSA, Roth IRA and 401k, then you don't have any space left to replenish the $500 expense. In that case you are best off paying the $500 expense out of take home income and leave the aggregate HSA/Roth/401k balance as high as possible.

JustinR wrote:I don't understand the examples that are like "pay expense from HSA, contribute that amount to 401k."

What? I understand the examples where you contribute the money to a Roth IRA, but I don't understand how paying medical expenses from your HSA has anything to do with contributing to a 401k afterwards.

It is about the total amount you have in tax advantaged accounts. It assumes you have the cash to pay the $500 medical expense from take home income. Should you do that or should you allow yourself to be reimbursed from the HSA for the $500 expense?

If you pay a $500 expense from the HSA, your HSA is down $500. Presumably you have hit your annual HSA max, so you cant top it up. So instead, you put that amount (or hopefully more) in your 401k. That way using $500 of the HSA did not decrease your total tax advantage account balance by $500.

If you pay the same $500 expense out of pocket, instead of from the HSA, it cost you $650 in earnings to get there, because you had to pay $150 taxes on the $650 to net $500.

If you are maxing your HSA, Roth IRA and 401k, then you don't have any space left to replenish the $500 expense. In that case you are best off paying the $500 expense out of take home income and leave the aggregate HSA/Roth/401k balance as high as possible.

This explains what I meant. If I was paying expenses from HSA, I wanted to try to fill extra tax advantaged space in another tax advantaged account.

I'm no expert on this, but the advice makes sense to me. An HSA has two benefits: contributions are not taxed (like pretax accounts) and gains are not taxed (like a Roth) in most states. If you put money in and spend it right away, you are taking full advantage of the pre-tax-like benefit. The advantage of leaving the money where it is is then roughly equivalent to having the money in a Roth. If you prefer pretax to Roth, it's then better to have more money in pretax accounts instead of the Roth/HSA. If you prefer Roth (which probably you don't), then it's up to you if you prefer the smaller differences that remain between having the money in an HSA or a Roth. I've found my HSA to be more trouble to manage than my Roth, so there's that.

shum wrote:I see no long-term tax advantage in moving money from an HSA to any other " tax-advantaged" fund. All other funds pay a tax sometime. Only your HSA avoids the tax all the time.

Mark me confused. : )

You avoid tax only if you use the money for medical expenses. I think the issue is whether to use it for medical expenses as you incur them or leave it alone, pay medical expenses with taxable money, save your receipts for the next 20 years (or whatever), then take the money out tax free in 2044 (or whenever). It only makes sense to do the latter if you are able to fill up all other tax advantaged accounts, as well as the HSA.

shum wrote:I see no long-term tax advantage in moving money from an HSA to any other " tax-advantaged" fund. All other funds pay a tax sometime. Only your HSA avoids the tax all the time.

A Roth is tax-free.

A traditional IRA or 401(k) is as good as tax-free, because of the deduction you get on contributions. If you are in a 25% tax bracket and put $4000 in your 401(k), that cost you only $3000 out of pocket. If the account doubles in value to $8000 and you withdraw in a 25% tax bracket, you get $6000 back. Thus you did just as well as if you invested $3000 in a tax-free account.

The main advantage of the HSA is that it is better than tax-free as soon as you make the contribution; it cost you only $2250 to put $3000 into your HSA. But once you put it there, it's no better than any other $3000 growing tax-free. Moving $3000 from the HSA to a Roth account is break-even, or a net gain if your HSA gets to be larger than your medical expenses.

Nice clear explanation. The issue arises if the HSA exceeds expected cumulative medical expenses, for me, a highly unlikely event. I would guess, given the limit on annual contributions, most of us would not have "too much" in an HSA. Thanks for taking the time to provide a concise explanation. Bravo!

shum wrote:I see no long-term tax advantage in moving money from an HSA to any other " tax-advantaged" fund. All other funds pay a tax sometime. Only your HSA avoids the tax all the time.

A Roth is tax-free.

A traditional IRA or 401(k) is as good as tax-free, because of the deduction you get on contributions. If you are in a 25% tax bracket and put $4000 in your 401(k), that cost you only $3000 out of pocket. If the account doubles in value to $8000 and you withdraw in a 25% tax bracket, you get $6000 back. Thus you did just as well as if you invested $3000 in a tax-free account.

The main advantage of the HSA is that it is better than tax-free as soon as you make the contribution; it cost you only $2250 to put $3000 into your HSA. But once you put it there, it's no better than any other $3000 growing tax-free. Moving $3000 from the HSA to a Roth account is break-even, or a net gain if your HSA gets to be larger than your medical expenses.

Bolded for emphasis - that part right there is the line of thinking that led me to be confused by the advice in the Wiki, that...

"If you are not maxing out your retirement accounts, you should usually pay current expenses from the HSA. If you are in a 25% tax bracket and have $1,000 in medical bills, taking $1,000 from the HSA, and taking advantage of the fact that this wasn't an out-of-pocket expense so that you can invest an extra $1,000 in your Roth IRA or $1,333 in your 401(k), works to your benefit."

But it seems it only works to your benefit, IF paying expenses allows you to contribute extra to another tax deferred account.

So...Paying $100 out of pocket and contributing $100 to 401k* > Paying $100 expenses out of a HSA and contributing $100 to a 401k. Because in the former you end up with $100 extra in tax advantaged space where in the latter you net zero.

And both of these are > Paying $100 from HSA and contributing nothing to extra to 401k. Here you are minus $100 in your tax advantaged space.

Drew31 wrote:"If you are not maxing out your retirement accounts, you should usually pay current expenses from the HSA. If you are in a 25% tax bracket and have $1,000 in medical bills, taking $1,000 from the HSA, and taking advantage of the fact that this wasn't an out-of-pocket expense so that you can invest an extra $1,000 in your Roth IRA or $1,333 in your 401(k), works to your benefit."

But it seems it only works to your benefit, IF paying expenses allows you to contribute extra to another tax deferred account.

So...Paying $100 out of pocket and contributing $100 to 401k* > Paying $100 expenses out of a HSA and contributing $100 to a 401k. Because in the former you end up with $100 extra in tax advantaged space where in the latter you net zero.

Yes, but the first situation isn't realistic. If you have to pay a $1000 bill, that is $1000 you must get out of some account. If it comes out of your HSA, it doesn't affect the amount of money you have available to invest; if it comes out of your checking account, that is $1000 you will have to replenish for paying other expenses and thus reduces your other investable assets by $1000.

The wiki's point is that it is better to have $1000 in a Roth IRA (tax-free) than in an HSA (tax-free only if used for medical expenses) and better to have $1000 in an HSA than in a taxable account (always taxed). Therefore, you should withdraw from the HSA if that allows you to put more money in your 401(k) or Roth IRA, but keep the money in the HSA if an HSA withdrawal would allow you to put more money in your taxable brokerage account.

Drew31 wrote:"If you are not maxing out your retirement accounts, you should usually pay current expenses from the HSA. If you are in a 25% tax bracket and have $1,000 in medical bills, taking $1,000 from the HSA, and taking advantage of the fact that this wasn't an out-of-pocket expense so that you can invest an extra $1,000 in your Roth IRA or $1,333 in your 401(k), works to your benefit."

But it seems it only works to your benefit, IF paying expenses allows you to contribute extra to another tax deferred account.

So...Paying $100 out of pocket and contributing $100 to 401k* > Paying $100 expenses out of a HSA and contributing $100 to a 401k. Because in the former you end up with $100 extra in tax advantaged space where in the latter you net zero.

Yes, but the first situation isn't realistic. If you have to pay a $1000 bill, that is $1000 you must get out of some account. If it comes out of your HSA, it doesn't affect the amount of money you have available to invest; if it comes out of your checking account, that is $1000 you will have to replenish for paying other expenses and thus reduces your other investable assets by $1000.

The wiki's point is that it is better to have $1000 in a Roth IRA (tax-free) than in an HSA (tax-free only if used for medical expenses) and better to have $1000 in an HSA than in a taxable account (always taxed). Therefore, you should withdraw from the HSA if that allows you to put more money in your 401(k) or Roth IRA, but keep the money in the HSA if an HSA withdrawal would allow you to put more money in your taxable brokerage account.

First, thanks for the explanation. This is helping.

I see what you're saying on scenario 1. I guess my thinking is that I would cut planned spending to pay for an expense. Granted this would only work for small expenses. Your $1000 expense would be something easily cut from spending.

So it sounds as if until I have all Roth space maxed out, it would be better to continue putting investable assets there, while paying for medical expenses from the HSA.

But after that, when I still have 401k space available, how would that then alter the discussion. Does it then just become more of a Roth vs. Traditional decision where we're having to consider tax rates in retirement?...with the caveat that the HSA is only used for medical expenses of course.

Drew31 wrote:So it sounds as if until I have all Roth space maxed out, it would be better to continue putting investable assets there, while paying for medical expenses from the HSA.

But after that, when I still have 401k space available, how would that then alter the discussion. Does it then just become more of a Roth vs. Traditional decision where we're having to consider tax rates in retirement?...with the caveat that the HSA is only used for medical expenses of course.

It is a Roth versus traditional discussion, with the HSA not quite as good as a Roth. Usually, in this situation, the traditional account is better then a Roth or just as good, so you should contribute to the 401(k). However, if you have a bad 401(k) and expect to retire in the same tax bracket, keeping the money in the HSA might be better.

grabiner wrote:
Yes, but the first situation isn't realistic. If you have to pay a $1000 bill, that is $1000 you must get out of some account. If it comes out of your HSA, it doesn't affect the amount of money you have available to invest; if it comes out of your checking account, that is $1000 you will have to replenish for paying other expenses and thus reduces your other investable assets by $1000.

The wiki's point is that it is better to have $1000 in a Roth IRA (tax-free) than in an HSA (tax-free only if used for medical expenses) and better to have $1000 in an HSA than in a taxable account (always taxed). Therefore, you should withdraw from the HSA if that allows you to put more money in your 401(k) or Roth IRA, but keep the money in the HSA if an HSA withdrawal would allow you to put more money in your taxable brokerage account.

I found your comments here helpful. I view the HSA as the best all around retirement vehicle, but get confused when considering whether to use it or not in the situation where you aren't maxing your retirement accounts. This year I won't be, but I will be adjusting my contributions to 401k or Roth in lockstep with how much spare cash is left each month, so paying out of pocket will directly reduce my contributions to those.

The part where my thinking may diverge from the wiki, is that I assume every dollar within an HSA will go in tax free, grow tax free, and come out tax free because I just assume health care costs will eventually catch up with it. It's kind of hard to wrap my mind around the right move for spending this year. Last year when everything was maxed it was much easier.

HSA USED FOR ONGOING MEDICAL EXPENSES: This is the intended use of an HSA. Contributions are pre-tax. Ongoing medical expenses are paid out of the HSA so are in effect tax deducible. It works basically the same as a cafeteria plan with less paperwork and no penalty if you don't spend the money.

HSA USED AS EMERGENCY FUND: This is what I do. Contributions are pre-tax. Ongoing medical expenses are paid out of pocket and records kept. As time goes by you have an emergency fund available to be used tax free with dollars that have never been taxed up to the amount of medical expenses that you have documented. This is basically what my wife and I are doing. At this point we documented medical receipts from the past several years that equal about 4 months worth of monthly living expenses and about twice that much in the HSA itself. In the unlikely event of a real emergency we could live off our HSA fund for 4 months on dollars that have never been taxed. If we never have any emergencies the HSA becomes a stealth IRA

HSA USED AS A STEALTH IRA. This is what I do with any HSA funds that don't get spent during emergencies which so far is all of them. Contributions are pre-tax. Ongoing medical expenses are paid out of pocket and documented. The money accumulates tax free until age 59.5 at which point it can be withdrawn tax free in amounts up to the amounts of documented medical expenses over the past decades. Excess money can be withdrawn as ordinary taxable income like any traditional IRA or 401K. However I am assuming that during retirement we will eventually have medical expenses or long term care expenses that will equal or exceed any amounts we manage to save in our HSA so my assumption is that we will never pay tax on our HSA regardless of the amount.

Bottom line, the HSA is the only type of account that lets you save money tax free and withdraw money tax free. Every other kind of tax advantaged account that I know of either taxes withdrawals (traditional IRA and 401k) or taxes contribution dollars (ROTH).

Even if you don't have enough earnings to max out all 3 types of accounts, the HSA still seems like the most advantageous type of account to fill up first. Especially if you have less than ideal 401k choices.

texasdiver wrote:HSA USED AS A STEALTH IRA. This is what I do with any HSA funds that don't get spent during emergencies which so far is all of them. Contributions are pre-tax. Ongoing medical expenses are paid out of pocket and documented. The money accumulates tax free until age 59.5 at which point it can be withdrawn tax free in amounts up to the amounts of documented medical expenses over the past decades. Excess money can be withdrawn as ordinary taxable income like any traditional IRA or 401K.

You have to be 65 before you can withdraw penalty-free from an HSA for non-medical expenses. Otherwise, this strategy works fine, and it's what I do with my HSA in order to expand my tax-deferred savings. (I don't use the HSA as an emergency fund because I would prefer to keep the HSA growing tax-deferred and pay emergency expenses from my taxable account. For similar reasons, I sold taxable stock rather than reimbursing myself from the HSA or withdrawing contributions from my Roth IRA for my home down payment; the small capital-gains tax I paid was worth keeping more tax-deferred money.)

texasdiver wrote:HSA USED AS A STEALTH IRA. This is what I do with any HSA funds that don't get spent during emergencies which so far is all of them. Contributions are pre-tax. Ongoing medical expenses are paid out of pocket and documented. The money accumulates tax free until age 59.5 at which point it can be withdrawn tax free in amounts up to the amounts of documented medical expenses over the past decades. Excess money can be withdrawn as ordinary taxable income like any traditional IRA or 401K.

You have to be 65 before you can withdraw penalty-free from an HSA for non-medical expenses. Otherwise, this strategy works fine, and it's what I do with my HSA in order to expand my tax-deferred savings. (I don't use the HSA as an emergency fund because I would prefer to keep the HSA growing tax-deferred and pay emergency expenses from my taxable account. For similar reasons, I sold taxable stock rather than reimbursing myself from the HSA or withdrawing contributions from my Roth IRA for my home down payment; the small capital-gains tax I paid was worth keeping more tax-deferred money.)

I stand corrected on the age. Either way, if one is diligent about documenting medical expenses over the years and manages to pay them out of pocket, one should eventually accumulate the ability to make large tax free HSA withdrawals at any time. The more I learn about the HSA the more astonished I am at how good of a deal it is. For a healthy family in a higher tax bracket who can cover the higher deductible insurance required to open an HSA it is an astonishingly good deal. If you are in a lower tax bracket and tend to run up lots of medical expenses then perhaps not so much.

Drew31 wrote:
So...Paying $100 out of pocket and contributing $100 to 401k* > Paying $100 expenses out of a HSA and contributing $100 to a 401k. Because in the former you end up with $100 extra in tax advantaged space where in the latter you net zero.

Yes, but the first situation isn't realistic. If you have to pay a $1000 bill, that is $1000 you must get out of some account. If it comes out of your HSA, it doesn't affect the amount of money you have available to invest; if it comes out of your checking account, that is $1000 you will have to replenish for paying other expenses and thus reduces your other investable assets by $1000.

grabiner, I am new to the forum. I got an HSA account this year and I am trying to understand how to get the most out of it.

After reading about it, I came up with the following way of thinking about paying for a current medical expense M. in case when Roth IRA or other tax-advantaged accounts are not maximized. There are
2 options for the source of medical payment M.: the expense can be paid from either HSA or taxable account.
2 options for paycheck placement: the after-tax portion of the paycheck equal to M. can go to either taxable or to Roth IRA.

For some reason only the first 3 options are usually discussed. I see that Drew31 mentioned option 4 above and you replied that it is not realistic. Why not? I think it may be realistic in some situations.

Compared to default option 1, options 2 and 3 result in -M change in taxable account while option 4 results in -2M change.

I think your point is that some people may not afford -2M change in taxable in option 4.
However, in the same vein, some other people may not afford -M in options 2 and 3, depending on how large M is and how much flexibility they allowed themselves when they chose which portion of their paycheck should go into Roth and which portion should go into taxable to cover their on-going expenses.

For people who allowed themselves very little flexibility, options 2 and 3 my not be affordable as they have already contributed to Roth as much as they could possibly afford to contribute. For people who allowed themselves enough flexibility, option 4 may be affordable and then it should be chosen.

CKM wrote:grabiner, I am new to the forum. I got an HSA account this year and I am trying to understand how to get the most out of it.

Welcome!

After reading about it, I came up with the following way of thinking about paying for a current medical expense M. in case when Roth IRA or other tax-advantaged accounts are not maximized. There are
2 options for the source of medical payment M.: the expense can be paid from either HSA or taxable account.
2 options for paycheck placement: the after-tax portion of the paycheck equal to M. can go to either taxable or to Roth IRA.

For some reason only the first 3 options are usually discussed. I see that Drew31 mentioned option 4 above and you replied that it is not realistic. Why not? I think it may be realistic in some situations.

If you aren't maxing out your retirement accounts, then you need to keep a certain amount in your taxable account (as an emergency fund, and for other short-term needs such as a planned car purchase), and you have no reason to keep more than that. Therefore, you should never have option 4; having this option implies that you had too much in your taxable account, and you should have contributed the $M to your retirement accounts even before you had the medical bill.

Thus, if you aren't maxing out your retirement accounts, your choice is between 1, 2, and 3. 3 is clearly better than 1, since the $M that you don't need in taxable is better in a retirement account. In this situation, 3 is better than 2; you have more money in the Roth and less in the HSA, and the Roth can be used for anything in retirement and likely has better investment options.

If you are maxing out your retirement accounts, then your only choices are 1 and 2, and 2 is better because it gives you more tax-deferred savings.

grabiner wrote:
If you aren't maxing out your retirement accounts, then you need to keep a certain amount in your taxable account (as an emergency fund, and for other short-term needs such as a planned car purchase), and you have no reason to keep more than that. Therefore, you should never have option 4; having this option implies that you had too much in your taxable account, and you should have contributed the $M to your retirement accounts even before you had the medical bill.

Thus, if you aren't maxing out your retirement accounts, your choice is between 1, 2, and 3. 3 is clearly better than 1, since the $M that you don't need in taxable is better in a retirement account. In this situation, 3 is better than 2; you have more money in the Roth and less in the HSA, and the Roth can be used for anything in retirement and likely has better investment options.

You assume that $M is not needed in taxable when you compare option 1 to others. Then, however, using the same logic as that in your first paragraph, you should have contributed $M to your retirement accounts even before you had the medical bill. Then, options 2 and 3 would not be available either.

Most people have some flexibility in their taxable account. For instance, if they think of it as an emergency fund, they can accept that it can be slightly higher or lower, depending on some unpredictable expenses, like medical bills.

I think you admit this flexibility, too, when you write that $M may not be needed in taxable. I think the question for everyone is how much flexibility do you have and how big the medical bill M is.

If there is no flexibility, then options 2, 3, 4 are not available to you. You have already contributed as much as you could possibly afford to Roth and you can't afford to pay $M from taxable. Your only choice is to pay from your HSA.

If there is enough flexibility to accept a hit of $M to your taxable, then 2 and 3 are available (and option 3 should be chosen).

If there is enough flexibility to accept a hit of 2*$M to your taxable (perhaps, because $M is not very large), then option 4 is available to you and should be used.

Bumping this thread (linked from the wiki) as I am still not convinced it is correct to pay out of pocket rather than from the HSA (when maxing out all retirement accounts)

The analysis seems to be missing a few real-world things:

1. Cost of record keeping and reimbursement submissions. Am I really going to be able to keep detailed records for 30 years and then spend the time converting them to reimbursements? How costly (in time) is that relative to just using a debit card now?
2. Investment option cost. e.g. Lively (one of the best HSA per other reviews) charges $2.50/month to invest. You are going to need at least an HSA balance of $4kish (1 year of contributions) for that number to get below losses from cap-gain taxes. This issue is fortunately trivial for large balances.
3. Assuming your lifetime HSA withdraws will meet appreciated contributions.
4. Possibly missing the detail that the HSA non-medical withdraw is only penalty free after age 65, not tax free. [1]

In the extreme, consider a simple case where I have a single medical expense of $1k at age 35 and don't bother keeping records and just pull all my money out at 65 (as though its an IRA). $1k in 30 years at 8% produces ~$9k in cap gains.

So let's pull the now $10k out at 65:
* If I had paid $1k from my HSA, I have $1k extra in a taxable account. Pulling $10k costs me $1360 in cap gains taxes (15% bracket)
* Let's say I had paid out of pocket, so I put $1k in my HSA (now $10k -- maybe a bit higher as dividends were tax free). If I don't remember to reimburse, I pay $2500 in ordinary income taxes (let's say 25% bracket). If I do remember, I reduce the taxable income by $1k and only pay $2250.

(Some of these numbers might be off, but let me know if they are off enough to break the analysis)

In some ways, HSAs seem to have the same problems as 529s: your future expenses are unknowable and you can end up in a situation where it was a bad decision to use the vehicle. Given those uncertainties, it doesn't seem like a bad idea to withdraw whenever you can - and put the money in an investment vehicle without restrictions

([1] Because of this, at what point does it even make sense to withdraw from the HSA? )

Last edited by ipo_fin_z on Tue Sep 11, 2018 6:55 pm, edited 1 time in total.

Bumping this thread (linked from the wiki) as I am still not convinced it is correct to pay out of pocket rather than from the HSA (when maxing out all retirement accounts)

The analysis seems to be missing a few real-world things:

1. Cost of record keeping and reimbursement submissions. Am I really going to be able to keep detailed records for 30 years and then spend the time converting them to reimbursements? How costly (in time) is that relative to just using a debit card now?
2. Investment option cost. e.g. Lively (one of the best HSA per other reviews) charges $2.50/month to invest. You are going to need at least an HSA balance of $4kish (1 year of contributions) for that number to get below losses from cap-gain taxes. This issue is fortunately trivial for large balances.
3. Assuming your lifetime HSA withdraws will meet contributions.
4. Possibly missing the detail that the HSA non-medical withdraw is only penalty free after age 65, not tax free. [1]

In the extreme, consider a simple case where I have a single medical expense of $1k at age 35 and don't bother keeping records and just pull all my money out at 65 (as though its an IRA). $1k in 30 years at 8% produces ~$9k in cap gains.

So let's pull the now $10k out at 65:
* If I had paid $1k from my HSA, I have $1k extra in a taxable account. Pulling $10k costs me $1360 in cap gains taxes (15% bracket)
* Let's say I had paid out of pocket, so I put $1k in my HSA (now $10k -- maybe a bit higher as dividends were tax free). If I don't remember to reimburse, I pay $2500 in ordinary income taxes (let's say 25% bracket). If I do remember, I reduce the taxable income by $1k and only pay $2250.

(Some of these numbers might be off, but let me know if they are off enough to break the analysis)

In some ways, HSAs seem to have the same problems as 529s: your future expenses are unknowable and you can end up in a situation where it was a bad decision to use the vehicle. Given those uncertainties, it doesn't seem like a bad idea to withdraw whenever you can - and put the money in an investment vehicle without restrictions

([1] Because of this, at what point does it even make sense to withdraw from the HSA? )

well, you gotta pay for medicare, which will only get more expensive. Use the HSA to pay for Medicare is my plan. Pretty sure that will get eaten up pretty quick for my wife and I.

Wiki articles represent a trade-off between providing advice and educating investors. Every investor has a different situation, so including information that's helpful for one person may be misleading for another - especially where taxes are concerned.

How can the wiki article be updated to represent a "real-world" situation? Post suggestions here. Wiki editors are welcome to edit the page directly.

To some, the glass is half full. To others, the glass is half empty. To an engineer, it's twice the size it needs to be.

Bumping this thread (linked from the wiki) as I am still not convinced it is correct to pay out of pocket rather than from the HSA (when maxing out all retirement accounts)

The analysis seems to be missing a few real-world things:

1. Cost of record keeping and reimbursement submissions. Am I really going to be able to keep detailed records for 30 years and then spend the time converting them to reimbursements? How costly (in time) is that relative to just using a debit card now?
2. Investment option cost. e.g. Lively (one of the best HSA per other reviews) charges $2.50/month to invest. You are going to need at least an HSA balance of $4kish (1 year of contributions) for that number to get below losses from cap-gain taxes. This issue is fortunately trivial for large balances.
3. Assuming your lifetime HSA withdraws will meet contributions.
4. Possibly missing the detail that the HSA non-medical withdraw is only penalty free after age 65, not tax free. [1]

In the extreme, consider a simple case where I have a single medical expense of $1k at age 35 and don't bother keeping records and just pull all my money out at 65 (as though its an IRA). $1k in 30 years at 8% produces ~$9k in cap gains.

So let's pull the now $10k out at 65:
* If I had paid $1k from my HSA, I have $1k extra in a taxable account. Pulling $10k costs me $1360 in cap gains taxes (15% bracket)
* Let's say I had paid out of pocket, so I put $1k in my HSA (now $10k -- maybe a bit higher as dividends were tax free). If I don't remember to reimburse, I pay $2500 in ordinary income taxes (let's say 25% bracket). If I do remember, I reduce the taxable income by $1k and only pay $2250.

(Some of these numbers might be off, but let me know if they are off enough to break the analysis)

In some ways, HSAs seem to have the same problems as 529s: your future expenses are unknowable and you can end up in a situation where it was a bad decision to use the vehicle. Given those uncertainties, it doesn't seem like a bad idea to withdraw whenever you can - and put the money in an investment vehicle without restrictions

([1] Because of this, at what point does it even make sense to withdraw from the HSA? )

well, you gotta pay for medicare, which will only get more expensive. Use the HSA to pay for Medicare is my plan. Pretty sure that will get eaten up pretty quick for my wife and I.

That's my plan too. And any medical expenses once on Medicare. I haven't taken a penny out of my HSA since I started it 13 years ago. It is approaching 6 figures now (and I haven't contributed the last 4 years) and I cannot get Medicare for 17 more years.

The HSA is the only vehicle I know of where you can get a tax deduction upfront and pay no taxes on the backend (when used for medical expenses).

The only big drawback I see is if it isn't left to your spouse it all becomes taxable in the year of death. Not good.

Most people grossly underestimate their healthcare costs in retirement. Current estimates are that a 65 year old couple retiring in 2018 will have $275K (2018 dollars) in healthcare costs in retirement.

These include Medicare Part B/D premiums (maybe increased by IRMAA), Medigap (not HSA qualified expenses*) and all OOP medical expenses. Not included in that estimate, but HSA qualified medical expenses; dental, vision, hearing and LTC (insurance an OOP expenses).

Would you prefer to pay those out of tax-deferred, taxable accounts or maybe your lifestyle. Many American's plans for a comfortable retirement are wiped out by healthcare costs. Anything that can help avoid that is a good thing. Significant HSA accounts are a good thing.

The only big drawback I see is if it isn't left to your spouse it all becomes taxable in the year of death. Not good.

Use it for charitable bequests where it is not taxed or maybe have a plan to take non-qualified distributions at the end game. If >= age 65, no early withdrawal penalties apply, just ordinary income taxes. Of course, the latter plan fails if you are < age 65 or you die suddenly with non-spouse beneficiaries.

No plan is perfect, but for mostit is the best high probability option.

If you retire before Medicare age and need to purchase insurance, you can use it for that, right? That could be a significant amount of money, depending on how early you retire.

Only COBRA premiums. So you get 18 months where you can draw from the HSA. (Medicare is the other case where HSA money can be used)

(Of course, if you buy the logic that you should keep the HSA growing, you might still want to contribute to your HSA during this window as well by selling funds in taxable and moving them to tax-advantaged HSA!)

Most people grossly underestimate their healthcare costs in retirement. Current estimates are that a 65 year old couple retiring in 2018 will have $275K (2018 dollars) in healthcare costs in retirement.

Great point - I hadn't thought the numbers were that high. With that said, you can still way overshoot that. e.g. if a married couple at age 30 contributes the max to an HSA every year, at 6% real returns, they'll have $800k (2018 dollars).

Perhaps a good way to handle this is to think about your trendline? If your account (with future contributions) is expected to be blow past amount needed in retirement, you should take the qualified medical expense withdrawals. Otherwise, if you are under that trendline, you should not.
(By way of specific numbers for a married couple, this means contributing net of withdrawals $2,500/year if you start at age 30; $3,300/year at age 35; $4,500 at age 40, etc. -- You should only be doing no withdrawals at all if you are starting your HSA within 20 years of retirement.)

How can the wiki article be updated to represent a "real-world" situation? Post suggestions here. Wiki editors are welcome to edit the page directly.

Ya, the trade-off is tricky to avoid over-complicating things.

My own proposed slightly modified language for "Paying current expenses out of pocket" is:

You should treat the HSA as a tax-advantaged account to pay for medical bills in retirement. If your HSA is not on track (expected growth and future contributions) to have sufficient funds to cover medical bills in retirement (expected to be ~$275k for a couple in 2018 dollars), you can further boost its size by not paying current bills from it. e.g. if you have $1,000 in medical bills, paying them from your taxable account leaves the $1,000 in the HSA to grow tax-free (and keeps the right to withdraw $1,000 tax-free in a future year), while paying them from the HSA leaves $1,000 in your taxable account, which will grow subject to capital gains taxes since you do not have any room for tax-sheltered contributions.

Once you are retired, you can withdraw from the HSA an amount equal to your past medical expenses plus any current expenses tax-free, and withdraw from your other accounts for non-medical expenses. HSAs can be used to pay medicare premiums and other medical expenses in retirement.

Your analysis does not factor in a real healthcare inflation rate. Over the longer term healthcare inflation has averaged 3% - 6% above the CPI.

The constraints apparent after the great recession have all but evaporated. In the last couple of years healthcare inflation has resumed it's march back to trendlines.

So that $275K will also be much greater.

Now factor in that very, very few people will have an HSA qualifying HDHP and be eligible for HSA contributions 100% of their career.

I still think the current Wiki is the best advice for the vast majority of individuals. Simple to follow advice is far better than complicated advice. I do not think the Wiki should be modified without much more analysis and consensus.

Your analysis does not factor in a real healthcare inflation rate. Over the longer term healthcare inflation has averaged 3% - 6% above the CPI.

You are correct I used CPI rather than healthcare inflation. However, where are you getting 3-6% above CPU? FRED is claiming it's 1.2% above CPI.

Anyway, with 4.5% returns net of health care inflation, the "don't withdraw" window moves up from 20 years until retirement to about 24. A change yes, but still a lot of people with HSAs are more than 24 years out.

As far as simplifying, I suppose this comes down to who the audience is. If the overwhelming majority of people reading the wiki that are affluent enough to max out tax-free space aren't going to over-contribute, the details might just add confusion. But if you have a good number of folks in their 30s coming by, it can lead to doing the wrong thing.

If you are going to make a projection based on decades of future performance. It should be based on long term past and future healthcare inflation and projected future growth not arbitrary percentages.

You are still neglecting the fact that it will be a rare individual even in their 30s who has an HDHP/HSA uninterrupted for decades.

The Wiki needs to represent the facts and circumstances of the vast majority of its readers. If there is to be a change to basic guidance it should be as an exception based on a well researched basis.

The Wiki needs to represent the facts and circumstances of the vast majority of its readers. If there is to be a change to basic guidance it should be as an exception based on a well researched basis.

Maybe the population here is skewed, but among the vast majority of the general population they will not need much more than: If you are not maxing out your retirement accounts, you should usually pay current expenses from the HSA.

Not sure why that even says "usually", what would the reason be for not paying those current medical expenses from the HSA?